How to Find Stocks to Trade: Part 3 (Scanners)

So far, we’ve gone over how to find stocks with news and how to find stocks with EquityFeed. Both of those strategies are intended to be used more for penny stocks. I use this next strategy mostly for NASDAQ’s, however, it can be used for a variety of different stocks.

If you don’t have a stock scanning tool by now, you need one. Stock scanning tools add a whole new dimension to your trading. They let you find the hottest stocks and filter out the junk. I’m sure there are a lot of great scanners out there. I use 2 main ones, and I will discuss them both.

FinViz: The Free Option

FinViz is a completely free stock scanner, so you have no reason not to use it. They have a wide variety of ways you can filter stocks, from fundamental statistics to technical indicators. Don’t let the “free” part deter you – this is a top-notch service. I will mostly use this tool after hours when I don’t feel like using my multi-monitor setup for other scanners.

Mess around with different scans and see what works for you. I don’t have many saved scans for this tool. I like to try different things. The goal is to create filters that align with your strategy. Experiment with different inputs until you get the right outputs.

My favorite part about this tool is that it displays a lot of charts all at once. This makes it easy to go through hundreds of charts and quickly spot the ones you like. Additionally, their technical charts include some trend lines and patterns that may help you spot nice charts faster.

finviz

E*TRADE Pro: The Paid Option

E*TRADE Pro Strategy Scanner is my main scanning tool. I use it during market hours and after hours as well. This tool is crucial to the success of my day trading strategies.

I believe that E*TRADE Pro charges $99, however, if you make at least 30 trades/quarter, the software is free.

The strategy scanner module allows you to set criteria for stocks you want to find. You can run real-time scans or scans from previous days.

I have four main scanners setup during trading hours.

Main Scanner

This scanner is the most active. It is intended to find hot stocks for scalp trades or breakout plays. A lot of the alerts are useless, but I have a good feel for which ones are the best, and I am constantly refining the scanner’s criteria.

I filter stocks by price, # of trades, dollar volume, and total share volume.

I receive alerts for stocks setting new highs, breaking above or below 20/50/200 day moving averages, forming symmetrical triangles, breaking out of consolidation ranges, forming bullish candlestick patterns, and more.

During the day, I keep an eye on a stock’s relative volume and the number of alerts it has had in order to better assess the quality of the alert quickly.

ssmain_1 ssmain_2

Social Scanner

This scanner tracks increased StockTwits activity for stocks. Remember, stocks are considered “in play” when they have a large audience and high volume. This increased social activity indicates that there is a large audience. You’ll also notice that there is high relative volume for most of these alerts. This scanner is nice because it only delivers a few alerts each day, so I’ll just glance at it a few times each day.

I only filter these stocks by price (under $10)

The only alert is increased StockTwits activity.

socialscanner

Penny Stock Scanner

This is another scanner that only delivers a few alerts each day. I use it to find good penny stocks for swing trades.

I filter stocks by price, dollar volume, and share volume.

I receive alerts for stocks setting new highs or lows, or breaking above the 50 or 200 day moving averages.

pennystockscanner

Watch List Scanner

I have hundreds of symbols on different watch lists, but I like to keep my main watch list small in order to stay focused. That being said, I don’t want to miss a move on a stock I am familiar with. So, I set up a scanner that scans all of my watchlists and alerts important activity.

I filter stocks by their dollar volume only.

I receive alerts for high relative volume, new highs/lows, and 20/50/200 day moving average crosses.

watchlistscanner

 In Conclusion

Scanners are a crucial tool for active traders. They allow you to be aware of what is going on in the market at all times. Additionally, they allow you to find stocks that are moving before other traders do. The point of showing my scans was just to give an idea of what you can do with these tools. When you create scans, they should align with your trading strategy. Otherwise, you will get a bunch of alerts that you can’t act on and the scanner is useless. Creating a good scanner takes time. I refine my scans on a regular basis. The more you use the scanner, the better you understand it. This allows you to filter out bad alerts and better refine your scanner inputs.

If you have any questions, feel free to contact me through the contact page on my site.

Check back tomorrow for the final post in this series, How to Find Stocks Using Social Tools.

How to Find Stocks to Trade: Part 2 (EquityFeed)

In my last post, I discussed how to find stocks using press releases. If you are trading every day, you can’t rely solely on good press releases. You need other options. The main tool that I use for finding good OTC penny/subpenny stocks is EquityFeed. The tool has a monthly cost, but there is a free trial available for you to test out the software. Let me make it clear that I am not trying to force this software on anyone. I am bringing it up because it is a valuable tool in my arsenal of trading software. You can probably apply some of these strategies without EquityFeed if you would prefer not to buy the software, however, I do recommend checking it out.

Let’s get right to it. Here’s are the many ways I find stocks with EquityFeed:

News:

Equity Feed has a streaming news module. This module constantly refreshes and alerts you whenever there is press releases or SEC filings for OTC companies during the trading day. This allows you to react to these catalysts much faster than traders who are using slower sources for news. It also allows you to view important data such as the stock’s volume, price changes, etc. You can filter the news by keywords, types of stocks, and other criteria.

news_equityfeed

Market View

Another one of my favorite features of EquityFeed is the Market View feature. This shows you all of the OTC stocks and allows you to sort them by different criteria. I split this feed into stock that are under $0.10 and stocks that are between $0.10-$0.50. Then, I sort the stocks by their dollar volume for the day or the # of trades. This allows you to see what the hottest stocks are during the day and make trading decisions accordingly. It also helps you find stocks that may be hot the next day as they continue their trends. Of course, you can filter these lists down even further, but I like to keep it simple.

marketview_equityfeed

Trading Alerts

This window gives you live trading alerts throughout the day and organizes them by type (each color is a different type of alert). You can create alerts for new highs, new lows, unusual volume, and block trades. This assures that you are always aware of what is going on in the market. When people bring up stocks breaking out in chat rooms or on Twitter, I have already been alerted in EquityFeed much earlier. Setting up alerts is very easy to do, unlike some other scanning tools.

tradingalerts_equityfeed

Filter Builder

EquityFeed has a feature called Filter Builder that allows you to scan the markets for stocks with very specific criteria. For example, you could create a filter for stocks with increased volume approaching their 200 day moving average. You can use this tool for live streaming during the day, however, I rarely do because I already have the trading alerts window. I will use this tool at night to find stocks that may be good swing trades or day trades for the next day. There are so many different filter variations you can make it so you need to constantly test new strategies.

filterbuilder_equityfeed

In Conclusion

EquityFeed is a great tool for people who trade a lot of OTC stocks. I recommend messing around with it a bit and seeing if it aligns with your needs. They have a 30-day free trial, and you can also get 10% off of your subscription when you use this link.  If you have any questions, you can feel free to contact me through the contact page on my site.

Check back tomorrow for Part 3 of this series where I will discuss Stock Scanners.

How to Find Stocks to Trade: Part 1 (News)

Before you can enter a trade on any given day, you need to have a list of stocks ready to trade. If you are an active trader, your watch list should be dynamic and reactive to the markets. Having the right stocks in your watch list can make or break your success on any given trading day.

Over the next few days, I will be posting a few articles detailing ways to find stocks to trade. Let’s start with the basics.

When building a watch list, you want to find stocks that are “in play” or “hot stocks.” If a stock is not in play, you really have no reason to be trading it. So, what exactly does it mean when a stock is “in play”? It means that there is some excitement/hype surrounding the stock. People are watching the stock closely and waiting to make a move. This means the stock has a large audience who may support the move when the time comes.

The first way to find a stock that is “in play” is through news sources. When a company releases news, it means something has changed within the business. Consequently, something should change with the stock price. The news is a catalyst. If it is good news, the stock should go up. If it is bad news, the stock should go down.

News Sources

Most of the news I read is for penny stocks, because these are the stocks that can move 20%, 40%, 50%+ on a single press release. I don’t read much news for bigger companies during trading hours because there are far too many of them, and if it is significant news, I will find the stock when it shows up on my scanners. Below are some places you can find news for penny stocks.:

OTC News (through the OTC Markets newswire) – News directly released through the OTC Markets website

OTC News (through third party wires) – OTC news from third parties.

InvestorsHub News –  News released through iHub. The better option for iHub news is to setup news alerts for companies you follow. You will get an email whenever these companies release news. The emails will often send before the news even shows up on the iHub site.

Marijuana Stocks News – This sector isn’t as hot anymore, but I used to check this news a lot. It’s worth a look every now and then.

EquityFeed – This is by far my favorite news source. Unlike other news sources, EquityFeed picks up on almost every news piece in real-time. There is a monthly cost, but a free trial is available if you want to test it out. I will be doing an entire post on how to find stocks through EquityFeed.

Filtering Through News

There are hundreds of press releases distributed every single day. This doesn’t mean that all of them are important. It’s very easy to send out a press release. I could send one out tomorrow if I wanted to. Learning to filter through press releases is a crucial skill for traders who incorporate news into their strategy. Considering that most of the news I read is related to penny/sub-penny stocks, I have to filter out a lot of junk.

You should be asking yourself two questions every time you see a press release:

1. How will this news effect the company?

2. How do I believe people will react to this news?

Both questions are equally important. For example, a company may release news that they sold 1000 cases of their product to a recognized brand like Circle K. You do your research and learn that this company’s profit margin is terrible and this sale will likely be a one-time transaction. You just answered the first question. Now, proceeding to the second one. How do you think people will react when they find out a small penny stock company landed a deal with a brand like Circle K? Less diligent investors may get excited and purchase shares. You can usually determine the reaction to news based on price action and volume. Just make sure to ask and answer both questions.

Let’s break news down even further now. We have a few categories of news that I think are important enough to discuss.

Good vs. Bad – This one is simple. Is the news good or bad? A company may report a toxic financing deal or bad earnings. This is bad news and you can expect the stock to go down. Contrarily, a company may report an impressive new contract or good earnings. This is good news, and you can expect the stock to go up. It’s as simple as that.

“Fluff” vs. Important News – Not all news is really “news.” Some companies just release news to keep people focused on their stock, or simply because they don’t know any better. By asking the question “How will this news effect the company?” you can filter fluff news from important news.

Expected vs. Unexpected News – You’ve probably heard the expression “buy the rumor, sell the news.” A lot of people buy a stock in anticipation of expected news. This means that the news has already been factored into a stock price. In these cases, a stock may go down on good news as traders collect their profits.

In Conclusion

Understanding how news will affect a stock price is not a science. You are not dealing with just the news; you are dealing with the mass reaction to the news. It still baffles me when I see certain press releases that move a stock’s price. You won’t be able to catch every move – focus on the best ones. Additionally, I will rarely trade solely based off of news and don’t recommend it. News is just a catalyst that brings attention to a stock. Once you find news that catches your eye, you should still apply your regular trading strategy to the trade (technical analysis, fundamental analysis, etc.)

Be on the look out for Part 2 of this series tomorrow: How to Find Stocks with Equity Feed.

Making Sense of Penny Stock Message Boards

If you have been trading penny stocks for awhile now, you probably visit some message boards. My “go-to” board is Investors Hub because it is one of the biggest boards for microcap stocks. While these boards can be a helpful part of your trading strategy, they can also be detrimental to your success if you do not know how to analyze the information available. Some people will tell you to just ignore message board banter, but I disagree. I think it is important to analyze the discussions because it gives you some insight into market sentiment, which I discuss in this post.

I am going to go over some things to look out for with these message boards, as well as some of the different characters you will see on these boards.

Meet the Gang

This isn’t everyone, but it’s a lot of the main players. (Yes, I am using animated characters)

The “Hype” Guy

Why they’re good: They can help support a run on the way up and get others enthusiastic about a company. Essentially, these guys are marketers that help market the stock.

Why they’re bad: They run out of credibility very fast by continuously pumping different stocks. Their job is to hype companies and they ignore price action. A lot of the times the hype is not based off of anything substantial.

What to look out for: It’s nice to see hype guys on a board for a stock you own. Essentially, you have someone marketing your stock for you, which may lead to higher gains. Just remember to never actually listen to anything these guys say. They have their heads in the clouds. Do your own research but know that the hype guys can help support a positive sentiment towards a stock.

Favorite Quotes:
“Blue sky breakout coming!”
“Shorts will be sorry soon”
“Gathering cheapies today”
“Know what you own”
“Holding long and strong!”

The Basher

Why they’re good: Bashers can balance out the hype guys. Sometimes, bashers are realists that can negate the wild fantasies of the hype guys. Additionally, the bashers can sometimes scare people into selling their shares, which can drive the price of a stock down, allowing you to buy cheaper shares.

Why they’re bad: Most bashers are not trying to help anyone; they are trying to see the stock price drop. A lot of their claims are unsubstantiated and they can panic investors. Having bashers in a stock you’re involved in can make it difficult for the stock to run at certain times.

What to look out for: Look for how many bashers are involved in a stock to see if they are the minority or majority. You should be cautious when there are more bashers because they can create a negative market sentiment that may lead people to sell their shares in fear.

Favorite Quotes:
“(Insert super low price target) coming soon!”
“SEC Suspension coming soon”
“Scumbag CEO fooled you all”

The Technical Analyst

Why they’re good: They can add some decent insight to the boards every now and then. This insight can be used to time entries and exits, however, you should not be looking to others for help with that.

Why they’re bad: Most technical indicators do not really matter for low volume penny stocks. Most people use reverse logic to prove their point. If someone wants the stock to run, they will look for indicators that support their theory.

What to look out for: Do not listen to a thing they say. Technical analysis is already tricky for penny stocks. Don’t listen to someone who has absolutely no credibility. If you want to use technical analysis, develop your own system. These guys are wrong about their analyses more often then not.

Favorite Quotes:
“RSI is about to enter power zone”
“Chart is primed for a run”
“Perfect fibonacci retracement, gearing for a major run!”

The High Roller

Why they’re good: High rollers can get a good crowd involved with the stock. Real “high rollers” will bring a lot of capital into a stock, which should be reflected in the stock’s volume.

Why they’re bad: Most high rollers are not actually high rollers. You don’t know anything about them or their lifestyle. Often times, these guys like to trade in groups (similar to pumpers), which means there is front loading and many people will get burned when the run is over.

What to look out for: Check a person’s reputation. See how their last couple of picks played out and analyze the validity of their previous claims. If you follow these guys, which I do not recommend, you want to make sure you time your entries and exits precisely.

Favorite Quotes:
“Big money coming into (Insert Stock Here)”
“Multi-bagger in the making”
“Still holding every single share. Huge things are coming!”

newbie

The New Guy

Why they’re good: New guys can sometimes be led to invest in anything. They buy into the hype from the hype guys which can help support a run. We’ve all been here before.

Why they’re bad: Newbies often waste space on boards by posting meaningless content. They may also believe that they are more experienced than they actually are. This makes it harder to properly analyze message board posts.

What to look for: Look for people who are exceptionally emotional. These are the new guys. Be aware of the fact that their posts have little validity. This isn’t meant to be rude; we’ve all been here before. You don’t really need to look out for newbies as they don’t affect the trading too much, however, it is important to know when someone is a newbie so you can understand where they are coming from.

Favorite Quotes:
“What stock should I buy today?”
“This is crazy! Why is this stock dropping?”

unbiased

The Rare Unbiased Analyzer

Why they’re good: First of all, an unbiased poster is extremely rare. These people are good because they create real discussion about a stock. They analyze both the positives and negatives and give weight to both. These traders can help you think about stocks from a rational, emotionless perspective.

Why they’re bad: Sometimes being unbiased means sharing negative facts about a company. This can lead to a strong negative market sentiment because the posts are valid and cause concerns.

What to look for: Make sure someone is really unbiased. Look over their previous posts and see what they have said in the past. Also, keep in mind that a rational analysis does not guarantee that a stock will behave in a certain way. Just because someone is unbiased doesn’t mean that they are right. Use these posters to understand a company better and to improve your own due diligence process.

Favorite Quotes:
“The P/E ratio values this company at (insert number here)”
“Let the market decide”

 

What to Look Out For

The Power of Posts – It almost seems a bit silly to do an entire post about message boards on a site about trading/investing. Do the message boards really matter? In my opinion, yes. Message boards can be extremely powerful because they can influence people’s trading/investing styles. Think about it, if you go to a board with nothing but positive comments, wouldn’t you be slightly more inclined to invest than if you went to a board with nothing but negativity? I’m not saying to make trades solely off of message board posts; that would be stupid. I’m saying you should use message boards to help gauge the market sentiment surrounding a stock. It’s a great tool. What better way to get into the minds of other traders? You will also want to keep in mind that everything posted carries some power. If you post something negative, you risk driving the price down. No, there is not a direct correlation, but you have to understand the power of your words. If you say something that deters one investor, that could have an effect on the stock. For example, whining about a company that you currently have losses on is foolish because you may scare away other investors. A lot of penny stocks have extremely low volume, meaning that there are few traders involved. While message boards won’t affect the prices of big board stocks, they can certainly influence the prices of low volume penny stocks.

Ulterior Motives – Anytime anyone posts anything on any board, they have some sort of motive. Sometimes, these motives can be as innocent as enjoying a conversation with other investors or making the trading day more interactive. More often than not though, people have an ulterior motive. If they want to see a stock price go up, they start talking positively about a company, and if they want the price to go down, they start talking negatively. Be careful when trying to make sense of all of this and think about why someone would post something. Remember, posting takes time and time is valuable. People need to have a reason to post. No one is out there trying to make you money. They are trying to make money for themselves. Keep that in mind and ask yourself why some people post what they do.

The Credibility of a Poster – The great thing about message boards is that all previous posts are easily accessible. If you are even thinking about listening to something someone says, you will want to make sure they are credible. Look at their previous posts and compare them to present results. If someone was hyping a stock and it dropped considerably, they are no longer credible to me. Similar to how historical data on stock charts can help show the future, historical posts from message board users can do the same.

Price predictions – Never listen to a price prediction: simple as that. No one has any real way of knowing how high or low a stock will go. Even when I am bullish on a stock, I don’t make price predictions because they would be unsubstantiated. Only the market can decide how high or low a stock goes.

Doomsday Predictions – People love to spread panic on days when traders are already panicked. When a stock is down, people will begin talking negatively about a company, making investors wonder why they invested in the first place. Feel free to analyze these predictions, but know that most of them are just made by bashers who are kicking investors while they’re down. They want to drive the price down because they are short the stock or want to buy in lower. These doomsday predictions will disappear the second the stock shows any sign of strength.

Fairweather Traders/Hindsight Analyses – This is a HUGE aspect of message boards that can be taken advantage of. People tend to change their opinions on a stock relative to its price action. If a stock is up, everyone is enthusiastic about its future. If the stock is down, everyone starts making doomsday predictions and finding all of the negatives about a company. Don’t get sucked into this emotional whirlpool. Be the person who can keep their eye on the prize. If you invested in a stock, you should have a good reasoning behind it. Don’t let that rationale falter when the stock drops in price. Of course, you should react accordingly, but don’t change your entire view on a company. The people panicking during the drop will be the ones rejoicing during the spike.

Reverse Logic/Technical Analyses – A lot of people make up their mind about a stock and begin finding evidence to support their opinion. This is the exact opposite of what the due diligence process entails.  Watch out for posters who have a strong, biased opinion and will use any information to support it. People will use anything from technical indicators to fundamentals to prove why they made the right choice. You should be looking for ideas that challenge your own, not blindly falling in love with a company.

Fundamental Valuations – There are a lot of fundamental valuations posted on message boards, some more substantiated than others. I’ll admit that I do fundamental analyses during my due diligence process, however, I never accept the findings as concrete proof that a stock will run. The market can easily ignore fundamental analyses, and it will for a majority of stocks. After all, most penny stocks should be worth $0. Use fundamental analyses as a fallback to a more solid trading plan and ignore hyped up analyses by others.

Conspiracy Theories – These are my favorites. When a stock is doing really well or really poorly, people start trying to make something out of nothing. They will go to great lengths to talk about potential deals a company could have, or potential reasons for their demise. “Just wait and see, this company will announce a deal with Apple soon.” No, they won’t. If something seems too good to be true, it is. Unless something is backed up by solid facts, it is garbage. Don’t invest based on “maybes.” Invest based on cold hard facts.

CEO Hate/Love – This is one of the most ridiculous ones I see. I even did a post on it. People love to act like they know a CEO personally. They think the CEO is watching out for them or that the CEO is pure evil. Don’t listen to either of these. The fact remains that you don’t know the CEO personally. They may be a great person, or they may be a great con man. Additionally, a lot of things may happen that a CEO has no control over. Once again, focus on the facts and ignore anything that may seem unsubstantiated.

How to Find Out Why a Stock is Moving

Day traders deal with so many tickers every day and it can be difficult to keep track of each and every one of them. All day traders have a different strategy for finding stocks to play. From stock scanners to trade alerts, there are plenty of ways to find good stocks to play each day. Regardless of how you find your stocks, you will always want to know why a stock is moving. Knowing why a stock is moving can help give you determine the magnitude of the move. I find most of my plays using a stock scanner so I have very little information when a stock is moving, other than the fact that it is moving. I don’t think I need to convince you that it’s important to know why a stock is moving, so let’s get straight to the point.

How to Find Out Why a Stock is Moving.

This list is in order of which to do first. Usually you can find out why a stock is moving from the first few items, but if you can’t, the others can be helpful.

  1. Look at the stock chart for multiple time frames – First things first, I will look at a stock chart for the ticker I am interested in. I will look at the intraday trend, the short term trend, and the long term trend using a few different charts. This can help give you an idea as to how the stock trades from a historical perspective. It can also let you know if the stock is moving on a technical breakout. I use my trading software for charts, however, you can always use StockCharts.com.
  2. Check for news – Most of the time, when a stock is making a big move, it is due to a news story or press release. I will check Yahoo Finance, as well as some other sources, to see if there is news moving the stock. This also includes analyst upgrades/downgrades. I will analyze the news to see how good/bad it is and try to determine how much it can move the stock.
  3. Check for a Seeking Alpha article – Sometimes, when there is no news on a stock, there may be a Seeking Alpha article. These articles have been able to move stocks a lot as of recently. Sometimes, the article will be shown on Yahoo News, however, sometimes it won’t so I check the actual Seeking Alpha website.
  4. Check the message boards – While message boards are usually filled with useless banter and wild predictions, they can be helpful to check when a stock is moving, especially if it is a penny stock. You have the advantage of a large group of people all working together to provide information. You can usually discover what is moving the stock because it will be mentioned on the board. I use Investors Hub as my go to message board. Don’t get caught up in listening to people’s opinions. Focus on the facts and learn why the stock is moving.
  5. Check Twitter – This is similar to checking a message board. Just do a search for your stock name in the Twitter search bar with a dollar sign in front of it (ex: $AAPL). Sort results by “All” instead of “Top”, and you can see all of the most recent tweets about your stock. Sometimes you can get some valuable insight. Once again, focus on facts not opinions.
  6. Check for a stock promotion – Stocks can move a lot when being pumped by people with large email lists. There are a few websites that keep track of these promotions. I like to use the Stock Promoters website to check quickly. I also subscribe to a lot of penny stock newsletters so I can find out earlier.
  7. Check for a short squeeze – A stock can run exponentially when shorts get squeezed out of their positions. I like to know how many shares are short and how many days it would take to cover. You can use the Short Squeeze site for some bigger stocks or OTC Short Report for penny stocks. I don’t think this data is always 100% accurate but it is still good to know.
  8. Check SEC Filings and OTC Market Filings – Sometimes a stock will move based on a recent SEC filing. Check the EDGAR website or the OTC Markets (for penny stocks) to see if a company just released an important filing.
  9. Check indices and sectors – Some stocks move with the market so it is important to know what the market is doing. I pay attention to larger indices like the S&P 500 (SPY), Dow Jones Industrial Average, and Russell 2000. I will also check certain sectors to see if they are “hot” an a given day. I use my stock software to get this information, but you can always check a site like Bloomberg to get your information. This kind of analysis is best for bigger board stocks like NASDAQs.

What Next?

Finding out why a stock is moving is just the first step. You will want to create a solid plan for trading the stock next, but that’s a completely different topic. The process outlined above is simple:

  1. Find out why a stock is moving
  2. Determine the magnitude of the move
  3. Create a plan to trade the stock

You can also use the resources mentioned above to find stocks for the next trading day. Knowing why a stock is moving provides clarity in the market and can help you become a better trader. The more you know about the move, the better.

 

 

 

How to Determine if a Company is Overvalued or Undervalued

One of my mains strategies for trading penny stocks is based upon finding undervalued companies and waiting for the market to realize their true value. These are the only penny stocks I will actually “invest” in, however, I still use my “Mentally Long Swing Trader Strategy” to protect my investments. Determining whether or not a company is properly valued, undervalued, or overvalued should be the first step of your due diligence/fundamental analysis. Most penny stocks are terrible companies that should be worth $0, so the majority of them are overvalued. Undervalued stocks are gems in the world of penny stocks. So, first things first, let’s talk about why a company’s valuation matters.

Why Does it Matter?

When you buy stock in a company and plan to hold your shares long term, you are buying a share of the company. Like any purchase in life, you want to make sure you are getting a good deal. Take an iPad for an example. At the time I’m writing this, you can get an iPad Air for $499 . If you go to a store and they are selling the iPad Air for $800, you would leave because that is ridiculously overpriced. Contrarily, if you found the iPad Air for $400 at another store, you would probably purchase it because it is a great value. The same logic applies to stocks. You don’t want to buy stocks that are overpriced (overvalued) because you won’t be getting a good deal.

Determining a company’s valuation is the first step to any further fundamental analysis, as it will help you assess every other piece of information you encounter. Whenever you see hear people talking about how good a company is fundamentally, you want to resort back to the company’s current valuation. Someone may say, “”X Stock” has major contracts with huge companies. They already brought in $1 million in revenue the first quarter of this year.” That statement alone sounds pretty good, especially if the company is trading at only a few cents per share. However, what if you looked at the company’s market cap and saw the company was already valued at $200 million? $1 million in revenue may not seem as impressive. Sometimes, positive news is already factored into a stock’s price. This is why properly valuing a company is the basis for all future fundamental analysis.

The Most Important Factor to Look At: Market Cap

The first and most important factor you will want to look at is a stock’s market cap. The market cap is calculated by multiplying the stock current share price by the amount of outstanding shares. So, if a stock trades at $0.04/share and there are 100,000,000 shares outstanding, the market cap is $4 million. You can see a company’s market cap by going to the “Company Info” tab on the OTC Markets website or you can calculate it yourself.

In another post, I talked about how market cap does and does not matter. To summarize, market cap doesn’t really matter for traders but it matters for investors. So many stocks have over inflated market caps but still run up exponentially. That being said, for the sake of finding undervalued companies, I use market cap as the basis for my future analyses.

The market cap is the value of a company as determined by traders and investors. If the market cap is $4 million, the company is valued at $4 million. Your next step is to decide whether the company is worth more or less than its current market cap.

What to Look At Next

The Basics

Common sense will go a long way here. Look at a company’s financial statements first. Analyze the raw data and draw some conclusions. Be confident and unbiased in your analysis. Look at revenues, profits, assets, etc. If a company is valued at $4 million and only has $3,000 in the bank, there might be a problem. That being said, the company may own $2 million in property to make up for it. Once again, always resort to common sense. If a company has $2 million in assets, but $1.8 million of them are intangible assets, is that as good as cash in the bank? Rhetorical question, but you get the point. Think deeply about the financials and use them to tell a story about the company. You can come to some great conclusions.

There’s no methodical, scientific approach to analyzing the financial statements in this way. It is an art and every company will be different. You don’t need some fancy degree in accounting to make sense of the data. As stated above, just use common sense and create a story for the company. You need to learn to be able to make sense of financial statements in order to be able to properly assess a company’s value. For example, picture a company releases the following data:

Quarter 1:Revenue: $1 millionProfit: $800,000 (80% margin)

Cash: $1 million

Quarter 2Revenue: $2 millionProfit: $1.2 million (60% margin)

Cash: $500,000

You could just look at the numbers and evaluate them. You’d see increased revenues and profits, and decreased cash. Now, try telling a story with it:

“During the first quarter the company did very well and brought in $1 million in revenue. Their new product just launched and there was a huge demand for it. They had an astonishingly high profit margin of 80%. The company’s efficiency for the quarter was reflected by the fact that they have $1 million in cash saved up. As the 2nd quarter came around, the company wanted to scale up their operations to increase revenues. Demand for their product was still high and they were able to double their revenue, however, they had some issues scaling up their business model. Profit increased, however, the profit margin decreased by 20%, so the company may not be able to scale up very efficiently. This could be cause for concern in upcoming quarters. This theory would be supported by the fact that the company’s cash supply was cut in half by 50% as the company strives to increase their revenues. A look at the cash flow statement should tell me how all of that money was spent.”

I know I diverged from my main point a bit, however, it is crucial that you have a way to understand financial statements in a way that makes sense to you. Telling a story helps you develop a more holistic view on the company’s business operations. I’m not saying you should only look for growth, revenue/profits, and cash. I am saying that you should analyze a company’s financial statements and know what that means in terms of how efficiently the company is running their business.

You should be comparing the numbers to the company’s market cap to see if they are in line. Once again, this is an art, and different investors will draw different conclusions. There’s nothing wrong with that. Just make sure to create a system that works for you.

After you look at the raw data, you can run some additional analyses to determine a company’s value.

EPS and P/E Ratio

This is one of my favorite/main methods of valuing a company. It is intended for big board stocks, however, it can be applied to penny stocks as well. After all, if you are looking at penny stocks as “investments”, you should treat them as such.

EPS stands for earnings per share. It is calculated by taking the company’s yearly net income and dividing it by the amount of outstanding shares. For example, if a company had a yearly net income of $1 million and has 100 million outstanding shares, the EPS would be $0.01. Always make sure to calculate the EPS manually because sites like Yahoo Finance rarely have the correct data for penny stocks. Most penny stocks have negative EPS, so any positive EPS is a good sign, however, you will want to use the P/E ratio to determine how good the EPS really is.

P/E stands for Price/Earnings and it is a popular ratio for determining a company’s value. To calculate the P/E of a company, you will want to divide the current share price by the EPS. So, if a stock has a share price of $0.05/share and an EPS of $0.01, the P/E ratio is 5.

There is no ideal P/E ratio. Average P/E ratios vary across industries. I like to look at the average P/E ratios for an industry and compare it to a company I am analyzing. You can find a list of average P/E ratios by industry right here. So if a company is in the “Accident & Health Insurance” industry (Average P/E of 10.5), and has a P/E ratio of 5, it could be argued that the company is overvalued.

The next step is determining what price a company is fairly valued at.

Determining a Fair Valuation

Determining what a fair share price is for a company is important because stocks can easily go from being undervalued to overvalued. If you bought a stock because it was undervalued and the market drives the price up, you will want to reevaluate your stance. Far too often, I encounter people who expect a stock to run forever because it’s a good company. The fact remains that a good company can still be overvalued. You need to know a company’s fair value so you can plan an exit strategy. If you got into a stock because it was undervalued, you should get out when it becomes undervalued.

Here’s how I determine a company’s fair value (based on share price). I’ll use an example to illustrate the point.

Let’s say you find a solid company in the “Auto Parts” industry (Average P/E of 18.6).

The company is priced at $0.05/share

The EPS is .$0.01.

Current P/E for this company is 5.

Right now the company could be considered undervalued. It becomes fairly valued when the P/E reaches 18.6. You can figure out the fair share price by doing the math.

P/E = Price Per Share / Earnings Per Share

18.6 = Price Per Share /.01

Price Per Share = 18.6 * .01

Price Per Share = $0.186

Based on this calculation, the stock is undervalued when below $0.186/share and overvalued when above $0.186/share. You can plan your entries and exits accordingly.

While this valuation tactic is helpful in determining a company’s value, it does not guarantee anything. A company can stay undervalued for a very long time. Additionally, the valuation was based off of industry averages and P/E ratios will vary within the industry. That being said, it’s a good start. If you find a company like the one used in this example, there is a lot of margin for error. According to the above calculations, the stock can run 372% before it is overvalued. Even if it ran 100%, that would be a good investment. If you find company’s that are extremely undervalued, there is a lot of wiggle room in your calculations.

The last thing you will want to account for is a company’s growth and upcoming catalysts.

Accounting for Growth

The PEG Ratio

The PEG ratio is similar to the P/E ratio, except it also accounts for company growth. I rarely use the PEG ratio, however, it is still good to know. The PEG ratio is calculated by dividing the company’s P/E ratio by their annual EPS growth. For example, if a company has a P/E ratio of 30 and their EPS increases from .01 to .015 over a year (50% increase), the PEG ratio would be .6. The lower the PEG ratio, the better.

I rarely use the PEG ratio by itself so I’m not going to go too much into it, but I do account for growth in other ways.

Plugging in Numbers: Accounting for Future Catalysts

The best way to account for growth and factor it into a stock’s fair value is by running some calculations based on the P/E formula.

For example, let’s say a company has the following stats:

Outstanding Shares: 100 million

Price Per Share = $0.05

Earnings Per Share = $0.01

Price/Earnings = 5

Let’s assume that this particular stock is at fair value right now, but there is talk of a big deal in the works. This big deal will bring in an additional $50 million in net profit over the year if it is finalized. We can use the above information to determine how much the stock price should run up accordingly.

Net Profit Added by New Deal = $50 million

Outstanding Shares = 100 million

EPS = Net Profit / Outstanding Shares

Value added to EPS from deal = $50 million / 100 million shares

NEW EPS = $0.50

Plug that back into the fair value P/E formula. We agreed that this stock was at fair value when the P/E ratio was 5 so:

5 = Price Per Share / $0.50

Price Per Share = $2.5

We can conclude that this $50 million deal would add $2.50 in value to each share of the stock, so the stock could technically run from it’s original price of $0.05/share to the adjusted price of $2.55.

You can run these calculation for all types of operating activities. It’s great for understanding the fundamental implications of new deals, and it can also be used to account for basic profit growth due to operations. If you believe that a company’s EPS will double next year, run the calculation using that EPS and find out what a fair price for the stock will be.

In Conclusion

There is no definitive way to value a company, however, you should create a system that works for you. Every investor uses different valuation methods and will draw different conclusion accordingly. This system works for me and has allowed me to discover sub-penny stocks that run over 1000% with time.

Remember, this is just a framework to help you better understand a company’s current value compared to its fair value. The numbers won’t be exact but they don’t need to be. You are trying to draw a simple conclusion about whether or not a company is undervalued. You do not want to say a stock will go up 400% because that is its fair value based on P/E calculations. That being said, if a stock can run 400% before reaching its fair value, its probably a good investment. Even if it only runs 200%, you end up well-off. It’s also important to keep in mind that the market may never realize a company’s true value. A company can stay undervalued for a very long time. Just because they are undervalued does not mean they will reach their fair value. You will want to look at other factors such as volume, hype, etc to determine if the company has the potential to reach its fair value.

It is important to run these calculations for every stock you invest in. They don’t matter if you are trading a stock or playing the charts, however, if you truly believe in a company, run these calculations to see where it stands.